The Principle of Relative Advantage Presented by Sarada Nag(64)

The Mercantilists View on Trade

In the 17th century a group of men (merchants,

bankers, government officials, and philosophers) wrote essays on international trade that advocated an economic philosophy known as Mercantilism. In their view, a country becomes rich if it exports more than it imports. The surplus in trade balance will result in an inflow of precious metals; gold and silver. The more precious metals means a richer and more powerful nation. Countries have to do their best to increase exports and restrict imports.

The Principle of Comparative Advantage

A nation, like a person, gains from trade by exporting the goods or services in which it has its greatest comparative advantage in productivity and importing those in which it has the least comparative advantage. David Ricardo

Who Gains?
Producers and workers in the export

industry gain as a result of higher world prices and a larger volume of trade; Consumers of the import competing good gain as a result of lower world prices and a larger supply; and Firms which use imported components and materials in their production process gain as a result of lower import prices.

Who Loses?
Producers and workers in the import-competing

industry lose due to increased competition from imports; Consumers of the export good lose due to the smaller supply available to the local market and higher world prices; and Firms which use exportable components and materials in their production process lose due to increased prices.

Trade Based on Relative Advantage

A. The Principle of Comparative Advantage (LCA)

According to it, even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still a basis for mutually beneficial trade. This nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller and import the commodity in which its absolute disadvantage in greater.

Relative Advantage and Opportunity Costs

A. Relative Advantage and the Labor Theory of

Value (LTV) According the LTV, the value or price of a commodity depends exclusively on the amount of labor going into its production. This implies that; 1) either labor the only factor of production or it is used in the same fixed proportion in the production of all commodities. 2) labor is homogeneous (i.e. of only one type). Since neither of the assumptions is true, we cant base the explanation of relative advantage on the LTV.

B. The Opportunity Cost Theory (OCT)

According to the OCT, the cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. Thus, the nation with the lower opportunity cost in the production of a commodity has a relative advantage in that commodity.

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